What's the Cause of the Subprime Crisis ?
I think there are broadly, two theories.
1) Housing Bubble—This is Dean Baker’s position. He argues we’re reaping the pain from classic bubble behavior (ala late 90’s) where everyone thought housing prices would go up forever, from borrowers to lenders and investors and everyone thought they could hitch their wagon to that eternally rising star. Of course, it was only a matter of time until the bubble crashed.
2) Financial innovation outpacing regulation—This is more or less what Krugman argued in his column the other day. The CDO‘s and SIV‘s created a thirst and secondary market for all sorts of bad investments (poorly rated by the rating agencies) and now this funny money is hitting the fan. The one data point in favor of this is the trouble that’s now brewing in the subprime auto-loan business, which were all packaged as CDO‘s. Obviousy, there was no “car boom” so if that sector starts to implode it suggests that originaly problem wasn’t just a housing boom.